Despite significant market demand for digital transformation tech and services, IBM’s (IBM) third-quarter results didn’t live up to our expectations, even when omitting its poor-performing Kyndryl business to be spun off soon. As IBM nears the spin-off of its managed infrastructure business, to be known as Kyndryl, we think that the real drivers for the remaining company lie in IBM’s consulting and software businesses. While consulting revenue surpassed our expectations (and consensus’), IBM’s software revenue missed—leaving us wary of the remaining company’s performance after the spin-off. Overall, we thought results were reflective of our ongoing thesis that while IBM has a narrow moat rating based on switching costs, IBM is undergoing a negative moat trend. Enterprise workload migration to the cloud already involves major business disruptions, making enterprises have to undergo switching costs regardless of if they stay with an IT services or software vendor or not.
All in all, we’re maintaining our fair value estimate of $125 per share for narrow-moat IBM. Shares are down 4% upon results, which has moved IBM into fair value territory. As a reminder, IBM plans to spin off shares of Kyndryl after market close on Nov. 3, so our $125 fair value estimate reflects the value of IBM’s stock pre spin-off. We plan to launch our new model for the remaining company by Nov. 4.
IBM reported revenue of $17.6 billion in the quarter, marking flattish year-over-year growth. While IBM’s global business services segment was a standout, growing at 12% year over year and surpassing our expectations and Factset consensus’, the rest of IBM’s businesses disappointed. The cloud & cognitive software segment grew only 3% year over year. And while global technology services, part of which will be spun off as Kyndryl, also fell behind our forecasts, with revenue down by 5% year over year, the miss is less significant in our view.
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